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2.10 Reverse acquisitions
Publication date: 31 May 2022
us Business combinations guide
Reverse acquisitions (reverse mergers) present unique accounting and reporting considerations. Depending on the facts and circumstances, these transactions can be asset acquisitions, capital transactions, or business combinations. See BCG 7.1.2 for further information on the accounting for when a new parent is created for an existing entity or group of entities. A reverse acquisition that is a business combination can occur only if the accounting acquiree meets the definition of a business under ASC 805. An entity that is a reporting entity, but not a legal entity, could be considered the accounting acquirer in a reverse acquisition. Like other business combinations, reverse acquisitions must be accounted for using the acquisition method.
A reverse acquisition occurs if the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes and the entity whose equity interests are acquired (legal acquiree) is the acquirer for accounting purposes. For example, a private company wishes to go public but wants to avoid the costs and time associated with a public offering. The private company arranges to be legally acquired by a publicly listed company that is a business. However, after the transaction, the owners of the private company will have obtained control of the public company and would be identified as the accounting acquirer under ASC 805. In this case, the public company would be the legal acquirer, but the private company would be the accounting acquirer. The evaluation of the accounting acquirer should include a qualitative and quantitative analysis of the factors. See BCG 2.3 for further information. Figure BCG 2-1 provides a diagram of a reverse acquisition.
Figure BCG 2-1
Diagram of a reverse acquisition
Diagram of a reverse acquisition
The legal acquirer is the surviving legal entity in a reverse acquisition and continues to issue financial statements. The financial statements are generally in the name of the legal acquiree because the legal acquirer often adopts the name of the legal acquiree. In the absence of a change in name, the financial statements remain labelled as those of the surviving legal entity. Although the surviving legal entity may continue, the financial reporting will reflect the accounting from the perspective of the accounting acquirer, except for the legal capital, which is retroactively adjusted to reflect the capital of the legal acquirer (accounting acquiree) in accordance with ASC 805-40-45-1.
2.10.1 Reverse acquisition involving a nonoperating public shell
The merger of a private operating entity into a nonoperating public shell corporation with nominal net assets typically results in (1) the owners of the private entity gaining control over the combined entity after the transaction, and (2) the shareholders of the former public shell corporation continuing only as passive investors. This transaction is usually not considered a business combination because the accounting acquiree, the nonoperating public shell corporation, does not meet the definition of a business under ASC 805. Instead, these types of transactions are considered to be capital transactions of the legal acquiree and are equivalent to the issuance of shares by the private entity for the net monetary assets of the public shell corporation accompanied by a recapitalization.
Any excess of the fair value of the shares issued by the private entity over the value of the net monetary assets of the public shell corporation is recognized as a reduction to equity.
2.10.2 Consideration transferred in a reverse acquisition
ASC 805-40-30-2 provides guidance on the consideration transferred in a reverse acquisition.
In a reverse acquisition, the accounting acquirer usually issues no consideration for the acquiree. Instead, the accounting acquiree usually issues its equity shares to the owners of the accounting acquirer. Accordingly, the acquisition-date fair value of the consideration transferred by the accounting acquirer for its interest in the accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity that results from the reverse acquisition.
In a reverse acquisition involving two public companies, there is a reliably measurable market value for the common stock of both entities. Accordingly, the acquisition-date fair value of the shares of the accounting acquirer should be used to measure the consideration transferred. The consideration transferred is determined based on the number of shares the accounting acquirer would have had to issue to the shareholders of the legal acquirer to achieve the same ownership ratio in the combined entity (i.e., give the shareholders of the legal acquirer the same percentage of equity interests in the combined entity that results from the reverse acquisition).
In a reverse acquisition involving only the exchange of equity, the fair value of the equity of the accounting acquiree may be used to measure consideration transferred if the value of the accounting acquiree’s equity interests is more reliably measurable than the value of the accounting acquirer’s equity interest. This may occur if a private company arranges to be legally acquired by a public company with a quoted and reliable market price, and the owners of the private company will control the public company such that the private company is identified as the accounting acquirer under ASC 805. If so, the accounting acquirer should determine the amount of goodwill by using the acquisition-date fair value of the accounting acquiree’s equity interests in accordance with ASC 805-30-30-2 through ASC 805-30-30-3.
Example BCG 2-38 illustrates the measurement of the consideration transferred in a reverse acquisition.
EXAMPLE BCG 2-38
Valuing consideration transferred in a reverse acquisition (adapted from ASC 805-40-55-8 through ASC 805-40-55-10)
Valuing consideration transferred in a reverse acquisition (adapted from ASC 805-40-55-8 through ASC 805-40-55-10)
Company B, a private company, is the accounting acquirer of Company A, a public company, in a reverse acquisition. The transaction is a business combination.
Immediately before the acquisition date:
- Company A has 100 shares outstanding
- Company B has 60 shares outstanding
On the acquisition date:
- Company A issues 150 shares in exchange for Company B’s 60 shares
- The shareholders of Company B own 60% (150/250) of the new combined entity
- The shareholders of Company A own 40% (100/250) of the new combined entity
- Market price of a share of Company A is $16
- Estimated fair value of a share of Company B is $40
What is the consideration effectively transferred for the acquisition of Company A by Company B?
Analysis
The fair value of the consideration effectively transferred should be measured based on the most reliable measure. Because Company B is a private company, the fair value of Company A’s shares is likely more reliably measurable. Assuming that Company A’s fair value is more reliably measurable, the consideration effectively transferred would be measured using the market price of Company A’s shares ($16/share) multiplied by the number of shares owned by Company A shareholders of the newly combined entity (100 shares) or $1,600.
If the fair value of Company B’s shares were more reliably measurable, the fair value of the consideration effectively transferred would be calculated using the amount of Company B’s shares that would have been issued to the shareholders of Company A on the acquisition date to give Company A an equivalent ownership interest in Company B as it has in the combined company. Company B would have had to issue 40 shares
to Company A shareholders, increasing Company B’s outstanding shares to 100 shares. Consideration effectively transferred would be $1,600 (40 shares times the fair value of Company B’s shares of $40).
2.10.2.1 Employee compensation in a reverse acquisition
An acquirer in a business combination may agree to exchange share-based payment awards held by grantees of the acquiree for replacement share-based payment awards of the acquirer. The accounting acquirer should apply acquisition accounting to the business combination regardless of the legal form of the transaction. In a reverse acquisition, from a legal perspective, outstanding share-based payment awards held by the grantees of the legal acquirer have not changed. However, from an accounting perspective, the awards have been exchanged for share-based payment awards of the accounting acquirer (legal acquiree). Accordingly, the acquisition-date fair value of the legal acquirer’s (accounting acquiree’s) share-based payment awards need to be evaluated to determine whether the awards should be included as part of the consideration transferred by the accounting acquirer or should be recognized as compensation cost in the accounting acquirer’s postcombination financial statements. See BCG 3.2 for detail on determining whether compensation arrangements represent compensation for (1) precombination vesting (i.e., part of the consideration transferred), (2) postcombination vesting (i.e., accounted for separate from the business combination as costs in the postcombination period), or (3) a combination of precombination and postcombination vesting.
For any share-based payment awards held by the grantees of the accounting acquirer (legal acquiree), the legal exchange of the accounting acquirer’s awards for legal acquirer’s awards is considered to be a modification under ASC 718 of the accounting acquirer’s outstanding awards. See SC 4 for further guidance on the accounting for modifications.
2.10.3 Presentation of financial statements (reverse acquisition)
The presentation of the financial statements represents the continuation of the legal acquiree, except for the legal capital structure in a reverse acquisition. Historical shareholders’ equity of the accounting acquirer (legal acquiree) prior to the reverse acquisition is retrospectively adjusted (a recapitalization) for the equivalent number of shares received by the accounting acquirer after giving effect to any difference in par value of the issuer’s and acquirer’s stock with any such difference recognized in equity. Retained earnings (deficiency) of the accounting acquirer are carried forward after the acquisition. Operations prior to the merger are those of the accounting acquirer. Earnings per share for periods prior to the merger are retrospectively adjusted to reflect the number of equivalent shares received by the accounting acquirer.
ASC 805-40-45-2 provides financial statement presentation guidance for reverse acquisitions.
Because the consolidated financial statements represent the continuation of the financial statements of the legal subsidiary except for its capital structure, the consolidated financial statements reflect all of the following:
- The assets and liabilities of the legal subsidiary (the accounting acquirer) recognized and measured at their precombination carrying amounts.
- The assets and liabilities of the legal parent (the accounting acquiree) recognized and measured in accordance with the guidance in this Topic applicable to business combinations.
- The retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination.
- The amount recognized as issued equity interests in the consolidated financial statements determined by adding the issued equity interest of the legal subsidiary (the accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with the guidance in this Topic applicable to business combinations. However, the equity structure (that is, the number and type of equity interests issued) reflects the equity structure of the legal parent (the accounting acquiree), including the equity interests the legal parent issued to effect the combination. Accordingly, the equity structure of the legal subsidiary (the accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition.
- The noncontrolling interest’s proportionate share of the legal subsidiary’s (accounting acquirer’s) precombination carrying amounts of retained earnings and other equity interests as discussed in paragraphs 805-40-25-2 and 805-40-30-3 and illustrated in Example 1, Case B (see paragraph 805-40-55-18).
Example BCG 2-39 and Example BCG 2-40 illustrate the presentation of shareholders’ equity following a reverse acquisition.
EXAMPLE BCG 2-39
Presentation of shareholders’ equity immediately following a reverse acquisition (adapted from ASC 805-40-55-10 and ASC 805-40-55-13 through ASC 805-40-55-14)
Presentation of shareholders’ equity immediately following a reverse acquisition (adapted from ASC 805-40-55-10 and ASC 805-40-55-13 through ASC 805-40-55-14)
Company B, a private company, is the accounting acquirer of Company A, a public company, in a reverse acquisition.
Shareholders’ equity immediately before the acquisition date:
Company A (accounting acquiree) |
Company B (accounting acquirer) |
||
|---|---|---|---|
Shareholders’ equity
|
|||
Retained earnings
|
$800
|
$1,400
|
|
Issued equity
|
|||
100 common shares
|
300
|
||
60 common shares
|
600
|
||
Total shareholders’ equity
|
$1,100
|
$2,000
|
On the acquisition date:
- Company A issues 150 shares in exchange for Company B’s 60 shares. Company A legally owns 100% of Company B.
- The market price of Company A’s shares on the acquisition date is $16/share.
- Fair value of consideration transferred is $1,600 measured using the market price of Company A’s shares (100 shares times $16)
The shareholders of Company B own 60% (150/250) of the new combined entity
How should the statement of shareholders’ equity be presented following the reverse acquisition?
Analysis
The presentation of shareholders’ equity of the combined company on the acquisition date is:
Combined company |
|
|---|---|
Shareholders’ equity
|
|
Retained earnings 1
|
$1,400
|
Issued equity
|
|
250 common shares 2
|
2,200
|
Total shareholders’ equity
|
$3,600
|
1 Retained earnings is based on the retained earnings of Company B, the accounting acquirer.
2 The amount recognized for issued equity (i.e., common shares outstanding) is the sum of the value recognized for issued equity interests of Company B (legal subsidiary) immediately before the acquisition ($600), plus the fair value of the consideration effectively transferred by Company B (i.e., the group’s interest in Company A (legal parent) (100 shares x $16/share = $1,600)): $600 + $1,600 = $2,200. However, the equity structure appearing in the consolidated financial statements (that is, the number and type of equity interests issued) must reflect the equity structure of the legal parent (Company A), including the equity interests issued by the legal parent to effect the combination.
EXAMPLE BCG 2-40
Restated presentation of shareholders’ equity following a reverse acquisition
Restated presentation of shareholders’ equity following a reverse acquisition
Company B, a private company, is the accounting acquirer of Company A, a public company, in a reverse acquisition. The transaction was consummated on 4/1/X2.
Immediately before the acquisition date:
- Company A has 100 shares outstanding ($1 par)
- Company A has total shareholders’ equity of $125
- Company B has 100 shares outstanding ($2 par)
- Company B has total shareholders’ equity of $1,850
On the acquisition date:
- Company A issues 400 shares in exchange for 100% of Company B. Company A legally owns 100% of Company B.
After the acquisition date:
- The recapitalized entity has net income of $300 for the period 4/1/X2 to 12/31/X2
How should the statement of shareholders’ equity of the combined company be presented at 12/31/X2, including the comparative period?
Analysis
Shareholders’ equity of Company B (accounting acquirer) immediately before the acquisition date is as follows:
Shares at par ($2) |
APIC |
Retained earnings |
Total shareholders’ equity |
|
|---|---|---|---|---|
1/1/X1
|
120
|
600
|
300
|
1,020
|
Shares issued 7/1/X1
|
40
|
110
|
150
|
|
Net income
|
250
|
250
|
||
12/31/X1
|
160
|
710
|
550
|
1,420
|
Shares issued 2/1/X2
|
40
|
190
|
230
|
|
Net income
|
200
|
200
|
||
3/31/X2
|
200
|
900
|
750
|
1,850
|
Restated shareholders’ equity of the combined company at 12/31/X2:
Shares at par ($1) 1 |
APIC |
Retained earnings |
Total shareholders’ equity |
|
|---|---|---|---|---|
1/1/X11
|
240
|
480
|
300
|
1,020
|
Shares issued 7/1/X11
|
80
|
70
|
150
|
|
Net income1
|
250
|
250
|
||
12/31/X1 1
|
320
|
550
|
550
|
1,420
|
Shares issued 2/1/X2 1
|
80
|
150
|
230
|
|
Net income1
|
200
|
200
|
||
3/31/X21
|
400
|
700
|
750
|
1,850
|
Recapitalization 4/1/X22
|
100 2
|
25 2
|
125
|
|
Net income
|
300
|
300
|
||
12/31/X2
|
500
|
725
|
1,050
|
2,275
|
1 In the prior year, the comparative information presented in the consolidated financial statements should be that of the legal subsidiary (Company B). However, the disclosure of the number and type of equity instruments issued to support that equity value is restated to reflect the capital of the legal parent (Company A) (i.e., shares with a $1 par). To calculate the shares at par, start with the ratio of Company B’s shares at 3/31/X2 (400 shares) to Company A’s shares (100 shares), which is a ratio of 4:1, and use that ratio to recast the shares for all periods.
2 On the date of the acquisition, the historical APIC account of the legal subsidiary (Company B) reflects the additional fair value of the legal parent (Company A total shareholders’ equity of $125) less the par value of the shares held by the legal parent’s precombination shareholders (Company A 100 shares outstanding at $1 par = $100). APIC = $125 - $100 = $25.
2.10.4 Noncontrolling interest in a reverse acquisition
Some shareholders of the legal acquiree (accounting acquirer) may not participate in the exchange transaction in a reverse acquisition. These shareholders will continue to hold shares in the legal acquiree and will not exchange their shares for shares in the legal acquirer (accounting acquiree). Because these shareholders hold an interest only in the legal acquiree, they participate in the earnings of only the legal acquiree and not the earnings of the combined entity. The legal acquiree’s assets and liabilities are recognized at their precombination carrying values (i.e., not recognized at fair value) on the acquisition date. These shareholders that will now become noncontrolling interest holders were not owners of the accounting acquiree and do not participate in earnings generated in the accounting acquiree. Therefore, in a reverse acquisition, the value of the noncontrolling interest is recognized at its proportionate interest in the precombination carrying amounts of the accounting acquirer in accordance with ASC 805-40-30-3.
Example BCG 2-41 illustrates the measurement of a noncontrolling interest in a reverse acquisition.
EXAMPLE BCG 2-41
Measurement of noncontrolling interest in a reverse acquisition (adapted from ASC 805-40-55-18 through ASC 805-40-55-21)
Measurement of noncontrolling interest in a reverse acquisition (adapted from ASC 805-40-55-18 through ASC 805-40-55-21)
Company B, a private company, acquires Company A, a public company, in a reverse acquisition.
Immediately before the acquisition date:
- Company A has 100 shares outstanding.
- Company B has 60 shares outstanding.
Company B’s recognized net assets are $2,000
On the acquisition date:
- Company A issues 140 shares in exchange for 56 shares of Company B.
- The shareholders of Company B own 58.3% (140/240) of the new combined entity.
- Four shares of Company B remain outstanding.
How should the combined entity recognize the noncontrolling interest?
Analysis
The combined entity would recognize a noncontrolling interest related to the four remaining outstanding shares of Company B. The value of the noncontrolling interest should reflect the noncontrolling interest’s proportionate share in the precombination carrying amounts of the net assets of Company B, or $134. This is based on a 6.7% ownership (4 shares / 60 issued shares) in Company B and Company B’s net assets of $2,000.
2.10.5 Computation of earnings per share in a reverse acquisition
In a reverse acquisition, the financial statements of the combined entity reflect the capital structure (i.e., share capital, share premium and treasury capital) of the legal acquirer (accounting acquiree), including the equity interests issued in connection with the reverse acquisition. Consistent with this financial statement presentation, the computation of EPS is also based on the capital structure of the legal acquirer.
ASC 805-40-45-4 and ASC 805-40-45-5 provide guidance on calculating EPS in a reverse acquisition.
In calculating the weighted-average number of common shares outstanding (the denominator of the earnings-per-share [EPS] calculation) during the period in which the reverse acquisition occurs:
- The number of common shares outstanding from the beginning of that period to the acquisition date shall be computed on the basis of the weighted-average number of common shares of the legal acquiree (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the merger agreement.
- The number of common shares outstanding from the acquisition date to the end of that period shall be the actual number of common shares of the legal acquirer (the accounting acquiree) outstanding during that period.
The basic EPS for each comparative period before the acquisition date presented in the consolidated financial statements following a reverse acquisition shall be calculated by dividing (a) by (b):
- The income of the legal acquiree attributable to common shareholders in each of those periods
- The legal acquiree’s historical weighted-average number of common shares outstanding multiplied by the exchange ratio established in the acquisition agreement.
Example BCG 2-42 illustrates the computation of EPS in a reverse acquisition.
EXAMPLE BCG 2-42
Computation of EPS in a reverse acquisition (adapted from ASC 805-40-55-16)
Computation of EPS in a reverse acquisition (adapted from ASC 805-40-55-16)
Company B, a private company, acquires Company A, a public company, in a reverse acquisition on September 30, 20X1.
Immediately before the acquisition date:
- Company A has 100 shares outstanding
- Company B has 60 shares outstanding
- Company B’s outstanding shares (i.e., 60 shares) remained unchanged from January 1, 20X1 through the acquisition date
On September 30, 20X1, the acquisition date:
- Company A issues 150 shares in exchange for Company B’s 60 shares. This is an exchange ratio of 2.5 shares of Company A for 1 share of Company B
- Earnings for the consolidated entity for the year ended December 31, 20X1 are $800
How should earnings per share be computed?
Analysis
EPS for the year ended December 31, 20X1 is computed as follows:
Earnings for the year ended December 31, 20X1
|
$800
|
Number of common shares outstanding of Company B
|
60
|
Exchange ratio
|
2.5
|
Number of shares outstanding from January 1, 20X1 through September 30, 20X1
|
150
|
Number of shares outstanding from acquisition date through December 31, 20X1
|
250
|
Weighted-average number of shares outstanding (150 shares × 9 / 12) + (250 shares × 3 / 12)
|
175
|
Earnings per share for year ended December 31, 20X1 ($800 / 175 shares)
|
$4.57
|
1 The number of shares to be issued that will give owners of accounting acquiree a percentage ownership interest equal to their ownership interest in the combined entity: (60 shares / 60%) × 40% = 40 shares.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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